The only summary of Union Budget you need to read

Union Budget 2015

Finance Minister Mr. Arun Jaitley presented the Union Budget for the financial year 2015-16 on February 28, 2015.

There are several ways to evaluate a budget – since there is no common set of expectations, it is impossible to categorize a budget as unanimously great or poor in most circumstances. Let’s try and look at this budget with respect to a few important parameters / considerations.

Size of the Central Government

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As per the recommendations of the Finance Commission, the government will transfer 1.78 lakh crore of extra money to the states as part of their share of central taxes. This is about 42% of the total central taxes, up from 32% earlier – an increase of 31%. Accounting for other transfers, about 62% of the money available (including non plan grants and loans, central assistance to states and UTs and centrally sponsored schemes) to be spent now in India will be with the states. This automatically reduces the size and hence the scope of spending for the central government – not just for this year, but on a recurring basis. Several key areas like healthcare, education and

Several key areas like healthcare, education and panchayati raj will now be funded not in Delhi, but every state will have discretion on what to do and how. This of course also means the need for greater accountability, transparency and results outcome by each state. This is not just an economic, but also a political risk. The lack of outcomes may be difficult to correct or explain and easy to pass buck on.

The increase planned for revenues and expenditure for 2015-16 is not very aggressive. Revenue goes up by about 1.6% and expenses by just over 5% for the next financial year. This does factor in an aggressive Divestment target of Rs. 69,000 cr – which may be tough to meet given the experience of last two years.

Overall, fiscal federalism is the keyword as far as financial management is concerned.

Overall: Positive

Headline Numbers

The fiscal deficit will be 3.9% of the GDP for 2015/16, against the original plan of 3.6%. The government will get to the Finance Commission recommendation of 3% fiscal deficit a year later than planned. This seems an area of caution, though the government has made it clear that the leeway taken here is for infrastructure spending, not for increased subsidization.

The Current Account Deficit is seen at 1.3% as against the 2.1% target that was being chased. This of course involves global and macro factors.

The GDP growth projections are higher at 8%-8.5% for the next year. But these numbers are now difficult to relate to the past, given the revised GDP series baselining. These numbers will become more relatable only if the corporate earnings keep pace and the tax collection numbers go up. Else, while in line with the international practices, the government will find it difficult to explain this switch from factor prices to market prices for GDP calculation and reporting.

Overall: Neutral

Subsidies

With the increased transfers to states, several centrally administered schemes will now depend on the states for funding, implementation and direction.

For some schemes, there will be no central grants at all going forward. About 12% of the centrally funded schemes fall in this category. About 38% of the schemes, including Swachh Bharata, AID Control and Rural Housing scheme will need heavy involvement of states. These are also some of the highlight areas of the Modi government in terms of messaging. Hence, the government has exposed itself to a big political risk for the purpose of financial prudence. This is a great, brave step, but can of course prove counterproductive too. Half of all central schemes will be fully funded by the central government including an increased allocation to the MNREGS.

The subsidies as whole will come down by 0.35% of GDP – a significant number but also helped by the oil price decline.

There was no specific detail on rationalization of other subsidy areas like fertilizers – which eventually have to be addressed by the government.

Overall: Positive on the direction taken; could have done more.

Spending on Key Result Areas

The central government spending focus seems to be on infrastructure – roads, railways and irrigation being the main thrust areas. Very importantly, the railway budget and the union budget seemed in line with each other on expectations of funding, involving private parties and seeking external funding.

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The government will now allow tax free bonds to fund these sectors, in addition to the increased outlay of Rs. 70,000 cr. There seems to be an attempt to bring all aspects of infrastructure spending through one umbrella of National Infrastructure Investment Corporation – it remains to be seen if NIIC becomes the nodal agency to raise finances for specific projects or if ministries will be allowed to go to the public directly and individually.

Additionally, the government announced 4 new ultra mega power projects, each with 4000 MW+ generation capacity. With coal linkages sorted out, this should serve as positive messaging for states to take similar measures. On shipping, the government will encourage ports to corporatize, which will pave way for reduced reliance on government funding and management control.

The government provided for increased credit for rural programs via a Rural Infrastructure Development Fund in additional to new credit and refinancing facilities for rural borrowers including farmers.

Overall: Positive

Enabling Legislation

The budget proposed a new law on curbing black money – owning foreign assets of an illegal nature. The law provides for severe criminal penalties for violations. This is good in theory but the implementation here will be the key. The clarity of how the assets are classified across a range of taxpayers and how the Income Tax authorities view past accumulation of assets and their future treatment will be critical. Improper implementation can lead to sticky harassment situations for taxpayers.

Government proposed to create a social security net focusing on health and accident insurance. This can be critical for the unorganized sector over a period of time. Again, how the schemes are funded and what involvement the government has will be the key implementation focus.

The biggest reform seems to be the decreasing monopoly of EPFO and ESI for pension and health insurance segments. The budget makes the use of employee provident fund voluntary and introducing competition to save via National Pension Scheme. The role of ESI will no longer be a monopoly – there will be a choice of opting for any IRDA approved player. These changes will again have a big impact over time. Increasing use of NPS will bring depth to the markets where the investments are eventually made. This will lead to availability a variety of direct benefit / contribution products over a long term horizon. Similarly, using IRDA approved insurers will be positive when seen in light of 49% FDI carrot in insurance.

The government proposes to use the massive post office network to increase banking operations – coupled with the Jan Dhan Yojana, this can be the fastest way to promote financial inclusion and deepening payments and banking markets. Again, the capability of the postal department to make this happen will remain in doubt till results are seen on the ground.

Despite a focus on “Make In India”, the policy area missed specific targeted sops for manufacturing in specific sectors and / or geographies in India.

Overall: Positive on the direction taken; big dependency on the speed and efficiency of implementation. Negative on the scope of coverage – could have done more specifically for the Manufacturing sector.

Market Legislation and Reforms

The government has promised to bring in several enabling legislations specifically for the regulatory structure of the market. The verbiage and provisions will be important to watch. However, the announcements are significant and far reaching.

Securities and Exchange Board of India (SEBI) will be the regulator for commodities too – this will bring in a unified view of risk management and counterparty credit risk in the market.

There will be a new bankruptcy bill, which will make it easier to close companies and liquidate businesses. This bill may have a negative impact too in the times when banks, specifically Public Sector Banks, are grappling with large NPAs on their books. How this latter problem is addressed remains to be seen.

There seems to be a broad agreement between the government and the RBI on monetary policy framework and inflation targeting responsibilities. The government has proposed to amend the RBI Act to facilitate this. On the other side, there will be a Public Debt Management Commission formed to regulate government borrowing guidelines and timing.

The budge envisages creating a Trade Receivables Discounting System for MSMEs which should improve the liquidity management for MSMEs. This will however need big technology support and adoption, and while in principle an interesting investment, the benefit realization here can be a few years off.

Overall: Positive

Taxation

This was the biggest mixed bag area for the budget. There were some positive points, but also a lot of iffy areas, which could have been avoided.

The General Anti Avoidance Rules or GAAR implementation is deferred by 2 years and the government has promised to keep the focus forward looking rather than retrospective. This should increase the overall confidence in Indian taxation system for foreign investors.

The Wealth Tax has been abolished but to offset the tax revenue, the government has brought in a 2% additional surcharge on those with 1 cr+ of taxable income. Notwithstanding the rhetoric on “shifting tax burden from super rich to hard working successful people”, this is a huge reform. Wealth Tax was routinely avoided and the effort involved in assessments and computation was not proportional the amount garnered – just over Rs 1000 cr. The 2% surcharge – being a surcharge and not an increase in the marginal rate – can be taken off at any time if the overall tax collections stabilize and look positive.

The Corporate Tax rate reduction from 30% to 25% over 4 years starting next year will be a positive. Most corporate entities today pay tax in the range of 20-23% effective rate, after a lot of effort being spent on claiming exemptions and searching for loopholes in the provisions. Bringing the rate down to 25% and taking off exemptions may promote at least a few of them to just pay the flat rate if the cost of mathematical management is higher than the additional 2-5% they will cough up.

Increasing Service Tax from 12.36% to 14% to bring the rates in line with the proposed GST rates from April 1, 2016 is the main negative. This will have a short term issue of extra tax burden across a range of services. Also small businesses, which don’t have the pricing power to pass on the tax increase, will see a decline in margin of 1.64% in their businesses. Also, retaining excise at 12.5% and these two rates diverging when the idea is to align with likely GST rates (14% – 18%?) does not look organized.

Areas like customs duty reduction on 22 items, but no changes on gold related import curbs, doubling of duty on imported commercial vehicles (hardly any market for it) and doubling the cess on coal looked arbitrary and not part of any larger plan. Especially the coal cess – which will definitely result in reduction of bid amounts on the fresh coal block auctions proposed for later this month.

The government did not offer any relaxation on the personal income tax slabs. It is quite likely that the government wants the indirect taxes to stabilize in the next 2-3 years before reforming the direct taxes. However, this was optically poor management, despite the new exemptions offered, whereby Rs. 4.44 lakhs worth of exemptions are available for all salaried individuals. In reality, to claim some of them in entirety, one has to have an income of Rs 15-20 lakhs (e.g. if your income was Rs. 5 lakhs per annum, you can’t take a housing loan big enough to claim Rs. 2 lakh in interest relief), so the exemptions don’t fully make up for the perceived taxation pinch.

Overall: Negative

Other Areas

The budget proposed several side casts – allocations for politics, optics and some forward looking areas not fully funded or fleshed out.

The government plans to encourage monetization and eventual “dematerialization” of gold, including creation of gold bonds. There will also be introduction of India made gold coins to offer a supply side solution to a big demand (and smuggling) area.

A new bank – MUDRA bank – will be formed to fund informal sector enterprises. Setting up a new bank is significant – the informal economy sees very little availability of credit. This can be a game changer over time, but the current Rs. 3000 cr refinance structure may not be very significant. Of course, over time, the government should not be engaged in this function at all, but given the wide gap for the unbanked today in India, this is a positive step.

Rationalization of capital gains for the real estate investment trusts and clarification of rules governing the taxation of offshore funds will be good for the industry. This will help the Private Equity players in a big way, providing more visibility and control of their operations.

Retaining the outlay for the Minority Affairs ministry and new schemes like “Nai Manzil” and “The Everlasting Flame” were some of the other political decisions.

Overall: Neutral

In summary, this budget was not about a roadmap for 2015-16, but incorporated structural, forward looking elements. The success of this budget will depend on greater center- state alignment, and an overall focus on good governance and implementation of policies and legislation. To this extent, the budget seems to have covered the short term acceptably, but keeping in play a big and transformational long term upside.

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